Alternative forms Alternative forms of financeof finance

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Adrian CarterAdrian Carter

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Trowers & Hamlins

Agenda

■ context/market■ bond issues■ private placements■ sale and leaseback■ Islamic finance■ Quasi-equity■ conclusions

Context/market■ the Banks■ £3bn lent/committed in 2010■ but

■ bank’s own finance■ Term■ Margin■ Backbook re-pricing■ appetite

■ an obvious need to look at alternatives

Bond issuesWhy suitable and why now■ historically attractive■ less so for last 10 years■ pricing has converged (5-6%)■ availability of funding■ long term (30 years)■ suitability for investors■ Clearly now a real alternative

Circle Anglia £399m 11/10 7.25%

TFC £371m 04/11 6.35%

L&Q £300m 01/10 5.55%

Sanctuary £320m 09/10 6.69%

Hyde £200m 07/10 5.12%

Notting Hill £180m 07/10 5.25%

Peabody £200m 03/11 5.25%

Bond Issues

Recent Issues

Bond Issues

■ series of IOUs■ listed on a recognised stock exchange■ marketed to institutional investors through financial

intermediaries (but, PfP retail)■ usually underwritten■ long term, fixed rate

What is it?

Bond issues

■ offering circular■ bond trust deed■ subscription agreement■ lead manager■ rating agent■ security trust deed?■ financial and other covenants

Documents and parties

Bond Structures

■ own name issues■ treasury vehicle as issuer■ on-lends to RP(s)■ which to choose?■ security trust deed■ marginal accounting advantage■ but, bank covenant compliance and guarantees

Structures

Bond issues

■ groups and clubs■ issuer as an independent vehicle■ THFC■ HALOS/Haven/FFH etc■ GB Social Housing and others■ by far the most used model■ smaller loans/access for other than the very largest RPs

Structures

Bond issues

■ size of issue (£150m+)■ timing issues■ real available source■ time consuming (security)■ short drawdown/no facility■ cost of carry■ covenant inflexibility■ but becoming increasingly covenant light■ a real alternative, available now

Pros and cons

Private Placements

■ a direct sale by the issuer of debt securities■ another series of IOU’s■ to sophisticated investors■ long term investments

■ not for resale

What is a private placement?

Private Placements

■ The market■ US$16bn in 1990■ US$839bn in 2005■ US$45.7bn (annual) in 2005

■ Originally domestic■ now US market is less than 50%■ UK accounts for c 10%

Investor Market

Private Placements

■ Issues by transaction size■ majority between US$100-200m■ UK issues not less than £50m■ Currencies can be US$/£/€/Yen

■ Issues by maturity ■ 7-15 years c 75%■ 15-30 years 10%■ exceptionally – 50 years

Investor Market

Private Placements

■ transaction preparation – information memorandum■ marketing – investor presentation■ circling – book building and pricing■ pricing and closing■ note purchase agreement■ US legal advice■ covenants drawn from domestic loans■ first fixed charge security

Process and documents

Private Placements

■ long term fixed rate funding■ no rating required■ sophisticated investors■ speed of execution■ standardised documentation■ confidential market

Advantages

Private Placements

■ flexibility of terms and structures■ reduced documentation requirements■ transaction costs■ issue size■ timing flexibility

Advantages

Private Placements

■ investor inexperience■ no real investor/issuer relationship■ amendment process for documentation can be

lengthy

Disadvantages

Sale and leaseback

■ disposal of freehold■ In return for a freehold interest■ premium receipt■ rental payment■ repurchase payment■ characteristics of a loan

Sale and leaseback

■ tax and accounting treatment■ security effect■ covenant light■ real deals being negotiated as we speak■ available, if not yet proven

Islamic Finance

■ a system of financing which complies with Islamic law■ acceptable means of financing for observant Muslims■ based on Islamic law (Shari’ah)

■ derived from Qu’ran and other sources■ not a codified system of law – different schools of interpretation

What is Islamic Finance?

Islamic Finance

■ need to achieve justice and equity – social enterprise is favoured■ no profit without risk – but profit is encouraged, assets should be put

to profitable use■ will not finance unlawful (haram) activities eg gambling, alcohol, pork

products■ the Qu’ran prohibits payment of “riba” or interest■ obvious synergy – needs to be socially responsible and ethical for

operations

Principles of Islamic Finance

Islamic Finance

■ there are approximately 300 Islamic financial institutions

■ US $400-500 billion of assets under management■ Islamic banks operate in 40 countries

Islamic finance worldwide

Islamic Finance

■ UK – FSA has authorised 6 Islamic banks■ Islamic Bank of Britain is the only one with a retail business

■ some non-Islamic banks offer Islamic products

Islamic finance worldwide

Islamic Finance

■ direct investment in RSLs unlikely because of requirement for high levels of debt finance

■ this would not prevent use of Islamic finance to fund individual projects or schemes

■ sale and leaseback model

Islamic investment in the social housing sector

Islamic Finance

■ problem: Islamic investors likely to be looking for shorter terms 5-7 years – RSLs historically have required 20-30 years

■ but remember where banks now are ■ margins have been historically low but now increasing ■ so time to reconsider?■ interested parties, but no transactions yet

Islamic investment in the social housing sector

Quasi Equity Investment

■ characteristics of RSL and Investor■ structural options■ exit arrangements■ things to think about

Quasi Equity Investment

■ no profit distributions to shareholders■ access to HCA funding■ TSA registration

Characteristics of RSL

Quasi Equity Investment

■ shares in risk and reward■ won’t want management hassle■ won’t want to jump more regulatory hurdles

Characteristics of Investor

Quasi Equity Investment

InvestorRSL Business

Ring fenced assets

HCA

Funds

Return based on performance of asset

Funding

The virtual SPV

Quasi Equity Investment

■ what is investor funding?■ cost net of grant ■ security for investor (if any) ■ performance based payment so no guaranteed

repayment■ incentives for RSL to manage well

The virtual SPV

Tenancies

Rent based on performance of asset

Quasi Equity Investment

The lease model

Investor (freehold owner)

RSL HCA

Tenants

Lease

Rent

Funding

Quasi Equity Investment

■ sale and leaseback – but no fixed return■ why a lease not a management agreement?■ avoiding irrecoverable VAT ■ insulating Investor from landlord role■ allow RSL to access HCA funding

The lease model

Quasi Equity Investment

■ long term investment ■ at expiry:

■ hand back to Investor with VP■ buy at then market value or fixed price■ option or obligation? ■ HCA/TSA view important here

Exit arrangements

Quasi Equity Investment

■ structural solutions possible■ need to attract investor interest■ scale and return will be key■ are RSLs interested in this type of model?

Conclusion

Conclusions

■ dearth of banking lending ■ bonds can replace to a degree■ but there are limitations■ PP market in its infancy, surety more to come■ sale and leaseback imminent■ the rest is, so far, all talk

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